This blog will try to dissect distressed debt investing, up and down the capital structure. We will look at current distressed debt situations, try to explain the ins and outs of how decisions are made in the distressed debt world, probably rant a few times about positions that are working against me, and hopefully enlighten some readers.

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7.29.2011

The Los Angeles Dodgers recent history has been a story stuck somewhere between Sports Illustrated and Page Six. Since 2009, Dodger owners Frank and Jamie McCourt have been locked in a very public divorce with the primary point of contention being the couple’s ownership of the baseball team. Until recently, the McCourt’s divorce drama seemed like it was inching towards resolution.

Now the Dodgers story seems more appropriate for a post on Distressed Debt Investing. In late June, a liquidity crunch forced the team into Chapter 11.

According to Dodgers Treasurer Jeffrey Ingram’s First Day Declaration, a “perfect storm” created the liquidity crunch. Ingram attributed the shortfall to three elements: 1) revenue reserves required by prior financing arrangements, 2) deferred compensation prefunding requirements and 3) weak attendance.

Ingram’s last point certainly has validity. Dodger attendance has plummeted since 2009 when the team went 95-67 before losing to Philadelphia in the NL Championship series. In fact, since the 2009 season average attendance at regular season Dodger home games has fallen 21.4% to 36,485 per game. This number is particularly notable as Dodger home games averaged 46,100 in the 5 seasons leading up to 2011.

Prior to the bankruptcy filing, the Dodgers attempted to secure a loan from Fox Sports to solve the impending liquidity issue. Fox Sports had retained the cable broadcast rights for Dodger games after selling the team to McCourt in 2004. Fox’s rights agreement is not set to expire until 2014, however the broadcaster has a “Right of First Negotiation” provision through November 2012. In exchange for the $385.0 million loan, the Dodgers agreed to extend Fox’s broadcast rights up to 17 years.

Approval of the Fox deal required consent from Major League Baseball. In June, Baseball informed the Dodgers the deal would not get approval. Instead, Baseball wanted the Dodgers to hold off negotiations for the broadcast rights until Fox’s First Negotiation provision expired. The implicit reasoning behind Baseball’s stance being a bidding war for the rights might lead to a more lucrative deal. Additionally, the Commissioner’s office noted they had reservations about a portion of the funds potentially being used to fund the McCourt divorce settlement. ($55.0 million of Jamie McCourt’s $100.0 million settlement would be funded via proceeds from the Fox Loan.)

The first inning of The Dodgers Chapter 11 proceedings has been no less interesting than the events preceding the filing. Last Friday, Judge Kevin Gross denied the team’s motion for DIP financing.

When the Dodgers filed in late June, Highbridge Principal Strategies had agreed to lend the team up to $150.0 million through a delayed-draw term loan. The court approved the DIP facility on an interim basis allowing the team to draw an initial $60.0 million. Major League Baseball subsequently objected to the Dodgers DIP motion as the league had also offered the Dodgers financing on better terms.

A comparison of the two facilities highlights the “plainly superior” Baseball offer:

Note: Initial Terms of the Highbridge facility were L+700 however, Highbridge lowered the interest rate by 1.0% when Unsecured Creditors Committee objected. The Unsecured Creditors subsequently dropped their objection.

A Memorandum Order from Judge Gross explained his rationale for denying the motion. The Judge’s decision was supported by two points: 1) The Dodgers were able to obtain unsecured financing and 2) the Debtors could not claim their decision to borrow from Highbridge was “business judgment.”

In regards to the first point, Gross explained how section 364(b) of the Bankruptcy Code disqualified the Highbridge Loan:

“The Court may not approve any credit transaction unless the debtor demonstrates that it has attempted, but failed to obtain unsecured credit. The Debtors not only failed to attempt to obtain unsecured financing (offered by Baseball), they refused to engage Baseball in negotiations because, they explained, Baseball has been hostile to Debtors.”

The second aspect of Gross’s ruling was McCourt violated a component of the business judgment rule. This rule generally allows corporate directors to exercise discretion when making business decisions such as whether a loan makes sense. The specific component Gross felt McCourt and the Dodgers did not satisfy relates to independent judgment:

“The evidence shows that if…McCourt did not seek court approval for the Highbridge Loan, he would personally owe $5.25 million to Highbridge. Such potential personal liability clearly compromised McCourt’s independent judgment…Additionally, Debtors refused to negotiate terms with Baseball to obtain a better and unsecured loan because of Mr. McCourt’s poor relationship with the Commissioner.”

The outcome had to be disappointing from the perspective of Highbridge. While a 9.0%+ return might be considered modest, the quality of the underlying assets is high. In 2010, Forbes magazine estimated the value of the Los Angeles Dodgers was approximately $727.0 million. Using the Forbes valuation as a benchmark suggests a $150.0 million DIP Loan would have significant asset coverage. Moreover, depending on the circumstances, the DIP lender could hold key negotiating leverage for a marquee asset.

The ruling also puts McCourt at a significant disadvantage. For the last few years, he has had a contentious relationship with Baseball. Leading up to Judge Gross’s decision, Baseball had accused McCourt of gross mismanagement and appointed a monitor to oversee the team. Indeed, McCourt’s rocky relationship with the league is puzzling. Most certainly, Judge Gross summed up McCourt’s strange attitude the best, “It is unclear to the Court how Debtors think they can successfully operate a team within the framework of Baseball if they are unwilling to sit with Baseball to consider and negotiate.”

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About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.

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